Better Resolution

Abstract

Wretched resolution compounded the crisis, and reforming resolution holds the key to preventing future crises. During the crisis authorities took steps, such as the rescue of Bear Stearns (see Chapter 3), which appeared to confirm the market’s expectation that some institutions were too big or too interconnected to fail. In the case of Lehmans (see Chapter 4) the authorities reversed course. Instead of rescuing Lehmans, they forced it into bankruptcy. This caused the market to revise its expectations of what the authorities would do, if a financial institution required intervention. Suddenly, loss given intervention loomed much larger, and this led market participants to withdraw funding from weaker institutions.